US Trade Deficit with China is not necessarily a bad thing
In this post, I am going to explain why America has a huge trade deficit, with China specifically, and prove why it’s great for its economy.
Trump has made trade deficit one of his biggest electoral issues. He has argued that it signifies the doom of American Pride and is the reason behind all of its economic woes. Using this as the reason he has started one of the ugliest economic wars the world has witnessed. This is nothing but bad economics and a bag of lies.
Before we go into specifics, let me explain a few important economic terms.
Dictionary (Skip this if you already know them)
- Balance of Trade: The balance between goods and services imported and exported. X sells Rs. 10 worth of goods to Y. Y sells Rs. 9 worth of goods to X. X has a positive balance of trade with Y (a Trade Surplus) and Y has a negative balance of trade with X (a Trade Deficit).
- Balance of Payments: This signifies the balance of net economic transactions of a country, the amount flowing out and the amount flowing in. This consists of two accounts, which must balance out to zero. One is Current Account, the other being Capital Account.
- Current Account records the net flow of income. This includes trade balance. If one has a huge trade deficit, it will negatively affect the current account.
- Capital Account records the net flow of ownership. If X invests his 1 Rs. on Y by buying property or by loaning the money to him, it’s a surplus for Y.
- Interest Rate – Refers to the percentage of interest paid on a loan. Countries borrow money by selling treasury bonds. They pay a certain interest to the lending nation on this.
- Tax evasion – When a person/company hides its incomes or somehow sends it to a jurisdiction having very low taxes, it avoids paying tax on it to its government. This is evasion of tax.
- Reserve Currency – The foreign currency kept in reserve by countries so as to use them to pay for imports. US Dollar is the world’s de facto reserve currency, as you can use it to pay for almost anything. For example, India keeps a lot of US Dollar to pay for its oil imports. Recall 1991, when we ran out of USD, a time of crisis.
US-China Trade Deficit
In 2017, the US had a trade deficit of $375 billion with China. That is, it imported goods worth that much more from China than it exported to it. The result being China earning at the cost of US. Bad for US, right. Wrong.
The reason behind this being the de facto reserve currency status of the USD. Everyone wants USD. They want to stash it in their reserves, so that they can use it to pay others. As a result, the US can print a lot of dollars and countries would still take them all, even if there is no real worth of those extra dollars. The US doesn’t need anything to back these extra dollars with. However, countries do need to provide their goods and services in exchange for those notes. This is exactly what China does. US buys valuable real stuff from China in exchange for its actually worthless dollars. This would be bad if USD were to lose its reserve currency status. No one would want dollars anymore. Everyone will start selling their dollars for something else in return. Value of the US dollar would fall severely, shooting inflation up and the US economy would go into recession. But this is not happening in any foreseen economic future of the world. So, China is going to keep taking in dollars, without affecting US’ buying power.
But beyond a point, China has got too much of dollars. China, thus, gives it back to the US. It gives it back for virtually nothing. But how does it give it back?
That Which Goes Comes Back
Let’s check the Capital account. China buys US treasury bonds, a lot of them. Right now it holds $1.2 trillion worth of US treasury bonds (nearly the size of the Mexican economy, another of Trump’s bête noire). That is, it has loaned the money to the US. But because China wants US to keep taking the loan (so that the US economy doesn’t go into recession), it demands a very low-interest rate. Also, the US doesn’t actually have to repay the loan because it pays China back in dollars, which again comes back to it. The government then uses this money for its budgetary spendings: on infrastructure, healthcare, education, etc. Its population, thus, enjoys a great lifestyle and consumes a lot, on virtually free loans given by others. Further, this money goes into research and development too, giving US a technological edge. Hence, the huge Multinational Corporations in the US. But look at these betrayers, they invest all their money in China. They build factories there and create jobs there, at a time when their countrymen are going jobless. Look at Apple, it’s all made in China.
Ah Lies! They are so easy to spread these days. Apple invests close to nothing in China. Its Foxconn, a Taiwanese company who has invested it all. But what about other companies, they must be investing a lot. Falsities. Of the Net foreign direct investments made by the United States, only 1.7% is in China. I will let you know where the majority of these investments go in the next section.
Apple, China and all the Investments Going Abroad
An iPhone is worth $750 in the states. Assembled in and imported from China. Thus, every time an iPhone comes into the US, its deficit with China increases by $750. But how much do Chinese actually earn from selling these? For all their labour, land and resources, they get a paltry $8. Where does the rest of the money go? It goes into paying for the parts, shipping, research, packaging, etc. produced in other countries. But most importantly, a huge chunk of that money goes to Apple, in the form of profits. So, the US public is not actually paying China a lot of money, it is paying Apple. Apple being a great American company duly pays taxes, enriching the government, doesn’t it?
Nope, it being a great capitalist stashes its money offshore, 94% of it. It keeps only 6% in the US to cover its expenses. So, what does it do with the stashed money? It buys bonds, both private and treasury: adding to US Capital Inflows from foreign countries. But it’s actually American money coming back to America. So, if the US capital account has a surplus of $1000 and $50 of it is Apple’s money flowing in from some other country, the real size of the capital surplus is $950. But we know capital account surplus cancels out current account deficit (which comprises mostly of trade deficit). The implication being the deficit which is shown as $1000, is actually $950.
- US Capital Surplus ($1000) = US Current Deficit ($1000)
- US Capital Surplus ($1000) – US Money disguised as Capital Inflow ($50) = US Current Deficit ($1000) – Money paid for mysterious goods/services (50$).
So, US’ trade deficit must have been overestimated and in reality, it has a much smaller trade deficit. The reason behind this is Apple’s China branch gets $750. Out of which $8 stays in China, a huge sum is paid out for other expenses, including patents, but not to Apple USA but Apple Ireland, the destination of the cash. Thus, the amount paid for patents is not recorded in US trade balance with China. Apple is only one of the many American companies using these tricks. More than $925 billions of tax evaded money is parked outside, contributing to inflated US trade deficit. Majority of this money comes back in the form of loans which go to companies and the government, who use this money for their expenditures.
As for the US FDI destinations, Netherlands, Luxembourg, Ireland, Bermuda, Cayman Islands and Switzerland get 16%, 12%, 7%, 5.5%, 5% and 3% respectively. For some reason, they don’t get a lot of barbs Trump throws around. Also, not many things in the US have a label saying made in Bermuda or in the Cayman Islands.
So, you see US economy keeps growing, productivity keeps rising and people keep spending because their currency is a reserve currency. They have a deficit as a result. Either they can have a deficit or have the above benefits.
 Cracking the China Conundrum, Yukon Huang, Pg. 128.
 Tim Worstall, “Effect of Apple’s new iPhone on China’s Exports, Trade Balance and GDP”. Forbes, September 3, 2014.
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